Equal Installment vs Equal Principal — which loan method costs less?
The repayment method you pick for a loan (equal installment, equal principal, or interest-only) changes your monthly payment and total interest. Here are the differences, the trade-off between monthly burden and total interest, and how paying early cuts interest.
The problem: same rate, so why pick a method?
When you take out a loan, the bank asks you to choose a repayment method: equal installment, equal principal, interest-only. It seems odd to split methods for the same amount at the same rate. The short answer: the method changes both your monthly payment and the total interest you end up paying. Neither is simply "better" — it's a trade-off between the monthly burden and total interest.
Interest only accrues while the principal is still owed. So the faster you pay down the principal, the less total interest you pay. The difference between the methods comes down to "how quickly the principal shrinks."
The three methods
Equal installment (annuity) pays the same amount (principal + interest) every month. Early on, more of it is interest; later, more is principal. The fixed monthly amount makes budgeting easy, so it's the most common.
Equal principal pays the same principal each month plus interest on the remaining balance, so payments start high and fall over time. Since principal drops faster, total interest is the lowest. Interest-only pays only interest throughout and repays the whole principal at maturity — the smallest monthly payment, but the principal stays to the end, so total interest is the highest.
| Method | Monthly payment | Total interest | Best when |
|---|---|---|---|
| Equal installment | Fixed | Middle | You want a steady monthly amount |
| Equal principal | Falls over time | Lowest | You can afford more early and want to save interest |
| Interest-only | Low (interest only) | Highest | Short term, repaying/refinancing soon |
Why paying early cuts interest
If you come into some money and prepay part of the principal, the remaining balance shrinks and all the interest that would have accrued on it simply disappears. The effect is largest when you pay early, while the interest share is still high.
That said, banks often charge a prepayment penalty if you repay within a set period (commonly three years), typically around 0.5–1.5% of the amount repaid. Weigh the interest saved against the penalty to see whether it's worth it.
How to choose
The right answer depends on your situation. This makes it simple.
- A steady monthly amount is easier to budget → equal installment
- You can afford more early and want to save on total interest → equal principal
- You'll only borrow briefly and repay or refinance soon → interest-only
- Prepay early when you have spare cash (after comparing the penalty)
Frequently asked questions
Isn't equal principal always better since total interest is lowest?
Total interest is lowest with equal principal, but the early payments are higher, so the monthly burden is heavier. If your cash flow is tight, equal installment's fixed payment may be more practical — it's not a decision to make on total interest alone.
What does a grace period do to interest?
During a grace period you pay only interest and no principal. Since the principal doesn't shrink, total interest increases. You lower the early burden in exchange for paying more interest overall.
Is it worth prepaying despite the penalty?
It pays off when the interest saved exceeds the penalty. The earlier in the loan and the longer the remaining term, the more interest you save, so it's often favorable. Compare the remaining interest to the penalty with a calculator.